6 mutual funds that fight bears and ride bulls

Commentary: Prepare for a huge move in stocks (up or down)

Conradde Aenlle

LONG BEACH, Calif. (MarketWatch) — It feels as though something big is about to happen in the stock market. Whether it’s a big up or a big down is hard to say; a case could be made either way.

Advocates of a further strong rally can take heart in the old adage that nothing succeeds like success. The market has achieved solid momentum; gains bring in more buyers, which fuel further gains, which bring in even more buyers.

As for the economic and corporate backdrop, both are mixed to benign. That’s the sort of “Goldilocks” state of affairs that investors relish: healthy, but not so close to ideal that the only way to go is down.

The argument for a big decline is that the advance has been spiced with too much relish. Many indicators of investor sentiment — opinions of advisory newsletters and retail investors, hedge funds’ exposure to stocks, the proportion of option traders betting on rising versus falling stocks — are at levels that show complacency, if not euphoria.

In the past such lopsided optimism has often occurred near significant market tops.

Relative strength

Another one of those indicators is the flow of money into equity funds. This varies depending on which types of funds are being measured and for precisely which period, but the net investment in stock funds over the last month or so has been at a level not seen since September 2007 or February 2000 — in other words a few weeks before one market collapse or a few weeks before another market collapse.Read more: Small investors buying up stocks.

Given the run that the market has had and the red flags that are waving, it probably makes more sense to get out of stock funds if you’re in them than to get in them if you’re out. Another approach is to hedge your bets through manager selection, by trying to find funds that strongly outperformed the market on the way down and on the way back up again.

That isn’t easy. Most funds can’t beat the market whether it’s rising, falling, going sideways or closed. The universe of funds is the market, and they all have management fees and other expenses that are not reflected in market averages.

Some managers outperform consistently on the way up by taking more risk than their peers; likewise some are stronger in bear markets because they take less risk, holding a lot of cash, for instance. The portfolios that these managers run are unlikely to show relative strength when market movements aren’t cooperating with their particular styles.

Still, there are six — and only six — diversified domestic equity funds in a universe of 6,001 in the database of the research firm Morningstar Inc. that ranked in the top 10% during the financial crisis bear market — October 2007 through February 2009 — and in the bull market since then.

The six funds lost 38.1% on average during the bear market, compared to a 50% hit for the 6,001 funds and for the Standard & Poor’s 1500, an index that comprises small-, medium- and large companies and broadly reflects the total stock market.

During the bull run since March 2009, the six funds rose 247%, on average, while the respective gains for the fund universe and the S&P 1500 were 125% percent and 127%.

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